Fed Slashes Key Rate, Will Lend to Hard-Hit Countries

By Neil Irwin and Anthony Faiola
Washington Post Staff Writers
Thursday, October 30, 2008

The Federal Reserve yesterday slashed a key interest rate for the second time in two weeks, while the central bank and the International Monetary Fund moved to prevent a string of financial collapses in emerging markets.

Taken together, the announcements marked extraordinary attempts to bolster the U.S. and world economies.

"Exceptional times call for an exceptional response," said Dominique Strauss-Kahn, managing director of the IMF.

Global stocks surged on news of the Fed's rate cut, but reaction in U.S. markets was muted. The Dow Jones industrial average, which gained 889 points on Tuesday in anticipation of the rate cut, closed down 74 points, or 0.8 percent, at 8990.96. Gains in overseas markets continued today, with stocks in Japan up more than 7 percent in early trading.

The Fed's actions yesterday came barely an hour apart. First, it cut its target for the federal funds rate -- the rate at which banks lend to each other -- from 1.5 percent to 1 percent, the lowest level since the aftermath of the dot-com bubble in the early 2000s. Later, it announced it would pump up to $120 billion into the central banks of Mexico, Brazil, Singapore and South Korea. The Fed has never lent on such a scale directly to developing nations, which are seen as having a greater risk of default.

The Fed and the IMF have had high-level talks in recent days about the gravity of the situation in emerging markets and the need to respond.

Given the scope of the need, the IMF said it would offer as much as $100 billion in emergency short-term loans to developing countries. In a departure from IMF norms, the loans would be rapidly deployed and have few strings attached.

The bursting of the biggest credit bubble in world history is battering emerging-market powerhouses that only months ago were seen as pillars of global strength, sparking runs on their currencies and dramatic plunges in their stock markets. The Brazilian real and Korean won, for instance, have both shed more than 30 percent against the dollar in the past two months as panicked investors have yanked billions out of the market. Hungary, also among those countries hit hardest, has struck a deal for a loan with the IMF, and the European Central Bank said Tuesday that it would join in the $25.1 billion bailout.

Making matters worse, many financial institutions in the developing world are struggling for cash as banks in the First World, themselves facing a credit crunch, pull in their lines of credit. Governments, corporations and, in some cases, even consumers have loans and other bets denominated in dollars, making those debts suddenly more expensive as their domestic currencies have sunk against the dollar.

By offering emergency loans to the central banks in key emerging markets, the Fed and the IMF are giving institutions more power to jump-start lending in their home countries, many of which have spent billions of their reserves defending their currencies in recent weeks.

At the Fed, policymakers made clear that they view the risks facing the U.S. economy to be severe. "The pace of economic activity appears to have slowed markedly, owing importantly to a decline in consumer expenditures," the Federal Open Market Committee said in a statement, unusually blunt language for such a formal statement. "Moreover, the intensification of financial market turmoil is likely to exert additional restraint on spending, partly by further reducing the ability of households and businesses to obtain credit."

The rate cut is designed to guard against the risk of a devastating downturn. In normal times, Fed rate cuts make it cheaper for businesses to borrow money to expand and for consumers to get auto loans, home mortgages and credit card debt. But in the current crisis, with banks reluctant to lend at any price, the rate's impact is uncertain.

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